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The Rise of In-House and Big Law’s Bet on M&A and Financing

The Rise of In-House and Big Law’s Bet on M&A and FinancingPrices have pushed clients to preserve liquidity. Cost savings have become the top priority, including savings on legal fees. In response to that pressure, some law firms will reinvent themselves and win market share. Law firms that do not, or cannot, because of lack of initiative, cultural obstacles or institutionalized cost structures will lose market share.
Cuff-link culture and large sunk cost pools might make a refresh of Big Law a tough proposition. Reinvention is not easy, but as Thomas Edison said, “opportunity is missed by most people because it is dressed in overalls and looks like work.”
But this is not the first time Big Law has been pushed to change. 125 years ago, law firms came in two speeds. One or two
lawyer professional practices, or firms in the Cravath mold. The latter (named after the white shoe firm that is still with us today) featured a small number of partners with a large number of associates.

Yes, a pyramid scheme. Maybe Amway should be paying royalties to Cravath? We digress. Over the years, especially in the 1980s, the Cravath model became the weapon of choice as law firms started to act more like managed businesses, and less like a profession. As the Cravath model became ubiquitous, it drove higher profits for partners. It also drove higher legal costs for clients, who looked to counter the trend. Two of those counter points are worth visiting.

The first key pressure was the rise of specialist corporate in-house departments. In the salad days of the Cravath model, companies were reliant on their Big Law firms to do everything. In 1987, General Electric hired Ben Heinemen as the head of Legal with the express purpose of creating an in-house legal department equal to a Big Law firm. He was sublimely credentialed, and perfect for the task.

By the time Mr. Heinemen was done, the company had over 1,000 top tier lawyers, with little need to rely on Big Law to do its day-to-day work. In addition to the skill upgrade, General Electric likely saved a lot on external legal spend. Many other large companies, like ExxonMobil, followed suit.

The second key pressure was the increased importance of General Counsel and senior lawyers in the corporate environment – particularly on matters of strategy and governance. If companies had been reliant on Big Law for everything, then they were certainly reliant on Big Law for its “opinion on important things”. The growth of sophisticated in-house departments also led to the increased influence of corporate counsel. Who better to advise a company’s President on a nuanced issue than the specialist lawyer that already knows the company and its business?

In this way, the presence of Big Law lawyers as secretaries or directors for clients started to fall away; along with the conflicts of interest that went with that dubious practice.

In response to these two trends, Big Law focused on transactional work, such as M&A and financing. The Big Law bet was that clients would not necessarily employ an army of lawyers that were needed only part of the time for a big deal or one-time listing. This bet paid off and sustained Big Law at high hourly rates for M&A and financings for years.

The downside, however, was a retraction in Big Law’s core skill set. By focusing on M&A and financings, other areas of practice were routinely deprioritized. Big Law now often lacks the depth of specialists to deal with the very tier-one specialty practice areas that it used to service.

These speciality practice areas tend to be further removed from transactional work, but much closer to operational concerns that in-house lawyer clients deal with. The result is that many Big Law firms are increasingly out of touch with their clients’ day to day business needs, and even in-house lawyers’ practice areas.

So, can Big Law adapt again in an attempt to reinsert itself in those practice areas?

There are two reasons this will be difficult. Firstly, the expertise for those areas has long left the ranks of Big Law – often for in-house positions or speciality boutique firms. Secondly, even if Big Law secured those specialists, it would be difficult to offer them to clients at competitive cost levels. Big Law’s institutionalized cost structure (e.g. expensive long-term leases and high support staff numbers) are an obstacle to the meaningful cost reductions that would allow Big Low to compete with nimbler boutiques.

If a Big Law firm cannot get passed these two challenges, it will be placing yet another bet on the same old horse that worked last time – a continued focus on M&A and financings to the exclusion of other niche areas.

After Covid-19 and the Oil Price Collapse, this seems like a more tenuous bet in an environment where public markets are set to be stagnant for some time. Some M&A work will result from consolidations, but in the medium term at least those files will pop up more rarely in a contracting market.